Landlord and tenant–Rent review clause–Application to set aside award of arbitrator appointed to decide a dispute as to rent payable under clause–Whether arbitrator misconstrued terms of clause–Effect on rent of tenant’s works to be disregarded–Arbitrator entitled to arrive at rent for ground floor on the basis of comparables–In the case of upper floors arbitrator, in the absence of comparables, resorted to devaluation of capital cost of improvements, adjusted for inflation, in order to arrive at rental equivalent–Method held not to be in accordance with parties’ intentions–Court ‘not a valuer,’ but can say whether a method of valuation is wrong–In present case method adopted by arbitrator involved a misconstruction of lease and therefore an error on the face of the award–Award remitted to arbitrator–Another judgment of Forbes J for valuers to study
This was an
application by landlords to set aside the award of an arbitrator appointed
under the terms of a review clause in a lease of four properties at 17-23 Woolwich
Road, Greenwich, originally houses but at the time of the lease shops with
upper parts. The applicant landlords were Estates Projects Ltd and the tenants
were the London Borough of Greenwich.
R C Pryor
(instructed by Anthony Leader & Co) appeared on behalf of the applicants
(landlords); G C Raffety (instructed by the solicitor, London Borough of
Greenwich) represented the respondents (tenants).
Giving
judgment, FORBES J said: In this case Mr Pryor moves the court for an order
setting aside the award of an arbitrator deciding the rent payable on a rent
review of certain premises in Greenwich. The applicants are the landlords and
the respondents the tenants, under a lease dated April 12 1973, made between
the parties.
There are only
three provisions in the lease that I think are relevant. The first is the
length of the term, for 53 years from December 25 1972; the second is the
reddendum–the rent should be for the first five years of the said term a rent
of £5,500 per annum; and for the successive periods of five years and a final
period of three years of the said term, the review periods, the rent to be
determined in accordance with the provisions contained in clause 2(1)(b).
Turning to
2(1)(b):
The rental
payable during the continuance of the review periods shall be the open market
value of the demised premises at the appropriate review dates but in any event
during the first review period not less than £5,500 per annum and in each of
the subsequent review periods not less than the rent which shall have been
payable during the immediately preceding review period AND it is hereby agreed
that the following definition and provisions shall apply:–
(i) The expression open market rental value means
the rental value of the demised premises in the open market which might
reasonably be payable between a willing landlord and a willing tenant on a
lease for a term of years equivalent in length to the residue unexpired at the
appropriate review dates of the term of years hereby granted with vacant
possession at the commencement of the term . . . and there being disregarded
any effect on rent of all work carried out by the council in fitting out the
demised premises suitable for use as offices and (if applicable) those matters
set out in paragraphs (a) (b) and (c) of subsection (1) of section 34 of the
Landlord and Tenant Act 1954 and there being disregarded (so far as may be
permitted by law) all restrictions whatsoever relating to rent or security of
tenure contained in any statute or order rules and regulations thereunder and
any directions thereby given relating to any method of determination of rent
such lease being on the same terms and conditions (other than as to the amount
of rent and length of term) as this present demise without the payment of any
fine or premium.
and:
(iii) The open market rental value shall be
determined in manner following that is to say it shall be such annual sum as
shall be:
(a) Specified in a notice in writing signed by or
on behalf of the landlord and posted by recorded delivery post in a pre-paid
envelope addressed to the tenant at its registered office at any time before
the beginning of a clear period of two quarters (but not greater than four
quarters) of a year immediately preceding the appropriate review date
(b) Agreed between the parties before the
expiration of three months immediately after the date of receipt by the tenant
of such notice as aforesaid in substitution for the sum specified in the
landlord’s notice under (a) above or
(c) Determined at the election of the tenant (to
be made by counter notice in writing served by the tenant upon the landlord not
later than the expiration of the said three months) by an independent surveyor
appointed for that purpose by the parties jointly in writing or upon their
failure to agree upon such appointment within one month immediately after the
date of service of the said counter notice then by an independent surveyor
appointed for that purpose on the application of either party alone to the
President for the time being of the Royal Institution of Chartered Surveyors
and in either case in accordance with the provisions of the Arbitration Act
1950.
And there is
one other subclause I should read, which is subclause (16) of clause 2, and it
is in these terms. The tenant covenants:
Not to use
the demised premises or any part thereof otherwise than as offices or as to the
ground floor as offices or shops.
There was, in
fact, no provision requiring the tenant to carry out the works referred to.
The premises
are a terrace of four elderly properties, originally, no doubt, houses but, at
the time of the lease, shops with upper parts. It appears that all the
improvement works, or the overwhelming proportion of them, were required to
bring the upper parts of the premises into a state which would comply with the
provisions of the Offices, Shops and Railway Premises Act 1963, and the
appropriate fire regulations, and thus permit their use as offices. At the
first review the parties could not agree about the rent and an arbitrator was
appointed under the terms of the rent review clause. The landlord is
dissatisfied with his award and therefore applies to set it aside.
I shall deal
at once with one of the main points made by Mr Raffety, for the tenant. He
says, quite rightly, that an arbitrator’s award is normally to be regarded as
final and cannot be set aside except for misconduct or where the award
is bad on its face. But an award is bad on its face if the arbitrator has
misconstrued or misinterpreted the contract, and that is the landlord’s
argument in this case. In any case there is a wider discretion to remit, rather
than set aside, if that is the appropriate course to adopt.
This case
began at a time at which I was considering a reserved judgment in another rent
review case, GREA Real Property Investments Ltd v Williams.* In view of some similarities both in the
facts and in the arguments addressed to me in that case and this one, I invited
counsel in this case to return after considering anything I had said in the GREA
case to address me with any further argument they might deem appropriate, and
they have both done so.
*Reported at
(1979) 250 EG 651, [1979] 1 EGLR 121.
The
contentions of the parties before the arbitrator were broadly as follows. The
landlord’s valuer took the value of the premises at the review date as improved
(this was agreed between the valuers to be £12,000 per annum as offices), and
then discounted that figure by (and I quote):
. . .
apportioning the cost of work that took place at 1973 prices by taking a figure
of 9 per cent on the capital value.
The tenant’s
approach apparently was first to value the premises (and again I quote):
. . . on the
basis that they continued in the same form as when the original lease was
granted, namely as shops with upper parts . . .
Justification
for this approach was said to be that:
. . . the
inference from the lease was that it was intended that the tenant should spend
money in converting the premises to offices but that the landlord should have
no additional rent accruing from the use, or change of use, arising from that
work.
It will be
remembered that subclause (16) provides that the only permitted use of the
upper floors of the property was as offices, the ground floor for shops or
offices. The tenant’s valuer does not appear to have pursued this approach,
though apparently it was Method A which he said he preferred, but he put
forward two alternative methods: B and C. Again I quote from the arbitrator’s
award:
Under Method
B, the tenant’s valuer took the agreed rental and then deducted all the costs
of the works at 1977 prices and applied an annual rate of 9 per cent and a
‘sinking fund’ of 3 per cent. His third method, Method C, was to apply a ratio
between the rent first paid, and the cost of the works in 1973, to the cost of
works at 1977 prices, to determine a rent.
The arbitrator
went on to adopt a method of valuation not put forward by either party. In
doing so, that was a course he was quite entitled to take, in my view. But his
approach was to value separately the ground and the upper floors. The reason
for this, he said, was that clause 2(16) required him to consider the possible
use of the ground floor as either offices or shops. The appropriate unimproved
rent of the ground floors he arrived at by first deciding that shop use, in an
unimproved state, commanded a higher rent than office use in that state; and
then, preferring the evidence of the tenant’s valuer based on comparable shops,
the answer was £6,300 per year. To find the rental value of the upper parts, as
improved, he started with the agreed figure of £12,000. He then went on:
It is
therefore reasonable to presume that the ground floor could be worth £3.75 per
square foot per annum, the first floor £2.75 per square foot per annum, and the
third floor £2.00 per square foot per annum.
As I
understand it those figures were produced as a result of his own expertise, and
I think neither party suggests that an arbitrator, in the position of this
arbitrator, is not entitled to do that. This sum produced an improved value for
the ground-floor offices of £7,000 and, of course, an improved value for the
upper floors at £5,000. The arbitrator does not appear to have considered any
question of the improved value of the ground floor as shops. I do not know
whether there was any evidence about that, or if there were to be any evidence
whether it would differ from the unimproved value, but he makes no finding
about it.
Turning to the
upper floors: he records a considerable difference of underlying fact between
the two valuers; again I quote from the award:
. . . the
landlord’s valuer stated that, in his opinion, the first floor would have been
worth £2.75 per square foot per annum, unimproved, giving a rent of £2,700 per
annum, but the second floor unimproved offices would have been worth £500 per
annum, which was a ‘spot figure’ because he considered the second floor could
only have been used as ancillary storage. The evidence of the tenant’s valuer
was that the upper floors would only be worth 10 per cent of the value of the
ground floor as if used as shops. I reject the approach of the tenant’s
surveyor. His approach produces a mathematical answer, on his figures, of £690
per annum, as against the landlord’s figure of £3,200 per annum.
I say that is
a difference of underlying fact, as it appears plain to me, as an inference
from that indication of the evidence, that the landlord’s valuer considered
that the first floor of these premises could properly and legally be used as
offices without the improvements; whereas it appears that the tenant’s valuer
took the opposite view, the view that they could not be used legally for office
purposes at all.
The arbitrator
went on:
The reason
why I reject Mr Jones’s approach [that is the tenant’s valuer] is that, at one
extreme, the failure to have a thermometer on the walls is a breach of the
Offices, Shops and Railway Premises Act; and such a breach could be remedied
for £1. At the other extreme a property could be in such a state that it would
have to be completely rebuilt before it could satisfy the Act. The fact that a
house has no roof on it does not mean that it only has a nominal value. What it
is worth is the value as a house with a roof on, less the cost of providing
that roof.
The method
adopted by the arbitrator was to take a figure for the cost of improvements,
including fees, attributable to the upper floors, and increase it in accordance
with the general increase in building prices between 1972 and 1977. This gave a
figure of £40,000. He went on:
I consider
that this sum should be regarded as improving the rental value of the upper
floors and I have adopted a divisor of 10.24 as being, in my opinion, the
correct deduction to be made in view of the wording of the lease and the
evidence I heard.
The result of
that exercise, dividing £40,000 by 10.24, was to produce a figure of £3,900 per
year which the arbitrator proceeded to subtract from £5,000, the improved
value, to arrive at a figure for the upper floors of £1,100 per annum; he then
added that to the £6,300 already determined for the ground floors and came to a
total figure of £7,400 as the rental value of the premises, disregarding the
effect on rent of the work carried out by the tenant. The 10.24 divisor was
selected, so I am told, as the appropriate figure based on the whole term of
the lease and not merely the portion remaining at the review date and including
the assumption that a sinking fund was to be provided. This latter point the
arbitrator based on a Lands Tribunal decision in a rating case.
Before me the
contentions have now, I think, been reduced to these: Mr Pryor says, for the
applicants, the arbitrator’s approach does not properly reflect the intention
of the parties. Mr Pryor maintains that the division into ground and upper
floors was not warranted. Now here I disagree with Mr Pryor and agree with the
arbitrator. The lease clearly, in my view, envisages the possibility of the
user of the premises as ground-floor shops and upper-floor offices, and in
arriving at an open market value, if there is a difference between the value of
the premises for use for one purpose or for another, it is obviously right to
take the higher value in those circumstances because that is what a market is
about. As I say, I accept the approach on this of the arbitrator. I think he
was clearly entitled to look at the rental value of the ground floor for use as
a shop, or shops, and I do not think the fact that that, as it were, divides
the premises matters, because it is a division in accordance, it seems to me,
with the user clause
Where there
are premises properly comparable with the subject premises in an unimproved
state, it seems to me, as I said in the GREA case, that it is sensible
to use such comparables to arrive directly at a rent for the premises which
disregards the effect on rent of improvements; it does not seem to me that it
is necessary to start off by finding what is the improved rent and then
deducting something to arrive at the unimproved rent if you have unimpeachable
comparables which you can use to arrive at the unimproved rent direct. Clearly,
the arbitrator in this case thought that the comparables put forward by Mr Jones,
the tenant’s valuer, were satisfactory, and he accepted them; and I think he
was entitled to do so. But the same approach cannot be adopted for the upper
floors, because, as I understand it, there are no directly comparable or
analogous cases available. None, that is, of upper parts in use as offices
without improvements of this kind. Of course, the tenant’s valuer maintained
that without the improvements the upper floors could not be used as offices at
all, because it would have been illegal to do so, and it was for that reason
that he only gave them a nominal value, and, as I have indicated, the only
permissible use for these floors under the lease was as offices. In the absence
of comparables for the upper floors as offices the arbitrator resorted to a devaluation
of the capital cost, adjusted to take account of inflation, in order to arrive
at a rental equivalent.
As I sought to
explain in the GREA case, I do not think this method is necessarily a
valid one. What must be observed is the intention of the parties, and that, in
cases such as this, is primarily twofold. First, the parties realise that in an
inflationary period the rent at the beginning of the lease would almost
certainly not represent a fair rent as between the parties at the end. They
therefore make an estimate at the beginning of the lease for a short period
only and put in review clauses to take care of the incidence of inflation
thereafter; the, rejected, alternative would be to seek to find some figure
which would be fair between the parties over the entire length of the lease–in
this case 53 years–a very considerable distance to peer into the future. And
secondly, I think the parties realise that because the tenant is paying for
works which will eventually inure to the benefit of the landlord, it is only
fair that the landlord, during the currency of the lease, should not get the
benefit, in rental terms, of those works and the tenant should. I emphasise
that that is because the works, as both parties would know full well, would in
the end inure to the benefit of the landlord. To adopt any capital revaluation
method to arrive at a rental value in those circumstances seems to me to be
probably not in accordance with those intentions in at least two respects.
First, it is the value of the tenant’s works, in rental terms, which has to be
eliminated and cost is not necessarily an index of value, though, of course, it
may sometimes be so. Certainly, the historic cost of building improvements
brought up to date by a kind of percentage increase, to take account of the
inflation of cost, does not necessarily amount to the same thing as the value
of the improvement in an inflationary period. And secondly, there is involved
the assumption that the cost of the improvements will be incurred by the tenant
at each review date, whereas the intention of the parties was that the
improvements, being already done, the landlord should not benefit from their
rental value during the whole of the lease although, of course, the value of
them would fall into his pocket, as it were, at the determination of the lease.
Parenthetically, my view is that this fact precludes, in these cases, the
assumption of a sinking fund.
Now this court
is not a valuer. All I can do is to say whether there is an error on the face of
the award, and there will be such an error if a method of valuation is adopted
which clearly does not follow the intention of the parties. I can say,
therefore, whether a method of valuation is wrong, but not necessarily what
method of valuation is right. It may be that a method of valuation is put
forward which stands the test of the intention of the parties; but if it is
not, the court cannot substitute its own views about valuation methods for
those of the experts in this field. All the court can say is, ‘No. These
methods do not properly reflect the intention of the parties.’ Mr Pryor, for the landlord, has, however,
suggested that the method put forward by the landlords in the GREA case
may well be the right method of valuation; it is worth, perhaps, just looking
at that for a moment. That was to take the rent agreed at the time of the
demise as representing the assessment by the parties of what was in truth the
value of the premises disregarding the effect on rent of the tenant’s
improvements. That would, of course, have been the value at the time of the
demise. To find the amount of the discount, which represents the tenant’s
improvements in rental terms, you must then find the value of the premises as
at the time of the demise on the basis that the improvements had been carried
out. Those two figures, if you can find them, will provide, so the argument
runs, an indication of the proportion of the whole improved rent which is
properly the landlord’s share on the one hand and the tenant’s on the other. So
far, it seems to me that that is admirably logical and in many cases may be
comparatively easy to assess. The argument then goes on:
You can then
apply the proportion so found in the agreed improved rent at the review date.
Now, as I
indicated in the GREA case, this method has considerable attraction, but
I had at that stage some doubt about the validity of assuming that the
proportion was always constant; a doubt which I expressed, in that judgment, in
this way (if I may quote a passage):
While the calculation
for 1969 [that was the time of the demise] would seem to rest on a firm base in
relation both to the intention of the parties and to the dictates of
commonsense, I am not so sure about the 1976 calculation [that was the first
review date]. This assumes that the proportion which the value of the tenant’s
works bears to the whole will remain constant whatever happens. It may be,
however, that inflation has had, or would have in the future, different effects
on site values, major construction works and works of improvement such as the
tenant’s here. These are the three components which make up the total value of
the building.*
*(1979) 250
EG at p 655.
Mr Pryor says
that the doubt I had in that case is unnecessary because once the improvements
are completed they become part of the realty so that there is no necessity to
divide the value of the premises into its component parts. I find that an
attractive argument, but again, as in the GREA case, I have no valuation
evidence upon that point and although such a method may have been adumbrated by
the landlord before the arbitrator, it was certainly not pursued in any depth.
Now, I put it
in that way because, as I sought to say in the GREA case, that method of
valuation in cases such as this seems to me to have a great many attractions. I
am not sure that the assumption that the proportion always remains constant is
necessarily valid in every circumstance and before being satisfied about that
one will, it seems to me, require some valuation evidence on that point. It may
be that my doubts about it are fanciful and that valuers could indicate that
one need not bother one’s head about that sort of thing. It may be, on the
other hand, that evidence would show that, in fact, there are differences. I do
not know, and as I have indicated, this court, not being a valuer, cannot
supply its own view about these matters for expert valuation evidence.
For the
reasons I have given I think that while the method adopted by the arbitrator in
valuing the ground floors can be seen as validly carrying out the intention of
the parties, I do not think the valuation adopted for the upper floors accords
with that intention. That, if I am right, is a misconstruction of the provisions
of the lease and, therefore, an error on the face of the award and, as such,
the court has a discretion to set the award aside. However, and I have not, I
think, heard
would rather remit it to the arbitrator, who is fully conversant with this
matter, which is of some complexity, and I think that that would be the best
way of dealing with it. The parties would then be given an opportunity of
leading further evidence on the question of the proper valuation method for the
upper floors and of adducing any further argument that was desirable. I can see
no objection to that taking place before the arbitrator who signed this award.
It may be, of course, that he does not want to take it up again, but that is a
different matter.
Now, Mr Pryor,
I have not heard either you or Mr Raffety, I think, on that point.
After some
discussion with counsel on both sides the judge made an order that the award
should be remitted to the arbitrator for reconsideration in the light of his
lordship’s judgment. It was also ordered that the applicants should have their
costs in any event.
